Hedge fund laws, starting a hedge fund, news and events…

Hedge Fund Operational Issues and Failures

We’ve published a number of thoughtful pieces on this blog from Chris Addy, president and CEO of Castle Hall Alternatives (see, for example, article on Hedge Fund Auditors). Today we are publishing a press release which announces a new white paper from Castle Hall detailing the various reasons which hedge funds fail. The press release also describes a new web database called HedgeEvent which was created by Castle Hall and details a number of hedge fund operational failures over the last few years.

I found the white paper to be interesting. I would imagine that some fund of funds and other types of hedge fund investors would find the information useful. A couple of interesting facts from the whitepaper:

The most common causes of operational failure in hedge funds are (i) theft and misappropriation and (ii) existence of assets (i.e. Ponzi schemes).

Long/short equity and managed futures are the strategies which are most likely to be subject to operational failure.

MONTREAL–(BUSINESS WIRE)–Castle Hall Alternatives, the hedge fund industry’s leading provider of operational due diligence, today published its latest White Paper, ‘From Manhattan to Madoff: the Causes and Lessons of Hedge Fund Operational Failure.’ The Paper’s analysis and findings are based on HedgeEvent, a comprehensive, web-based database of more than 300 operational events, now available to Castle Hall’s due diligence clients. HedgeEvent supplements HedgeDiligence, the firm’s existing client web portal.

The White Paper may be downloaded from www.castlehallalternatives.com/publications.php

Chris Addy, Castle Hall’s CEO, said “the colossal fraud perpetrated by Bernie Madoff, together with a number of other recent cases, has made investors acutely concerned by the risk of operational ‘blow ups’. However, there has been little systematic study of operational failure, meaning that investors have limited guidance as to the extent of this problem.”

“The creation of HedgeEvent, which has taken more than two years to compile, has enabled us to summarize key metrics related to hedge fund operational failure” said Addy. “From Manhattan to Madoff analyzes operational events by number, estimated loss, causal factor and by the strategy of the funds involved.”

HedgeEvent contains 327 cases of hedge fund operational failure through June 30, 2009. Madoff, with an estimated financial impact of $64 billion, is by far the largest; the remaining cases have an aggregate estimated financial impact of approximately $15 billion. Of the 327 operational events, 121 have an estimated impact of $10 million or more, and 31 of at least $100 million.

“While operational failures are material – Madoff spectacularly so – it does not seem that fraud is pervasive in the hedge fund industry” said Addy. “Investors should, however, be very focused on the lessons which can be learned from those hedge funds which did generate large losses. Many of these were well established firms which attracted capital from reputable investors.”

Across all Events, the most common causes of operational failure are theft and misappropriation followed by existence of assets (the manager claimed to own fake securities or operated a Ponzi scheme where reported assets did not exist). The most common strategies subject to operational failure are long / short equity followed by managed futures. It is notable that investors have traditionally viewed these strategies, holding largely exchange-traded securities, as straightforward with low operational risk.

“HedgeEvent is an invaluable tool for both Castle Hall and our clients” said Addy. “A lot can be learned from historical events: better knowledge can help investors avoid the losses, both monetary and reputational, of hedge fund operational failure.”

About Castle Hall Alternatives

Castle Hall Alternatives helps leading institutional investors, fund of funds, family offices and endowments identify and manage hedge fund operational risk. Castle Hall’s team draws on more than 30 years of direct due diligence experience and is the industry’s largest, dedicated provider of operational due diligence. More information is available at www.castlehallalternatives.com